Some Foreclosure Issues For Landlords and Tenants – Part 1
Some Foreclosure Issues – Part 1
Ownership of real estate can result in having a property foreclosed on, whether a personal residence or a rental property. Foreclosure of any property can result from a variety of events including loss of employment, catastrophic illness, or divorce. For rental properties, foreclosure can result from deterioration of the rental market due to changes in the local neighborhood or in the overall economy. The risk of foreclosure can be aggravated by government policies, as was the case for the most recent serious recession, an event from which the country is still not fully recovered.
A lot of owners of real estate lost their properties through foreclosure during the recent recession. While we can hope that the country will never again experience such an event, there is little certainty that future politicians will remember the reasons for the recent financial debacle or be willing to take the actions necessary to avoid a repeat. Accordingly, it is worthwhile to review some issues related to being an owner who is being foreclosed upon.
When financial conditions occur that will likely result in loss of a property to foreclosure, an owner may have to decide whether to go through a foreclosure or simply walking away and mailing the keys to the bank. The lending industry has even coined a term for the latter of those choices. It’s called jingle mail, because of those sets of keys that jingle around in their incoming mail.
Those who choose to mail the keys to the lender will still face the foreclosure process. And, as the lender’s foreclosure processing proceeds, an increasing number of delinquent payments, late fees, attorney fees and other costs will be layered onto the owner’s credit report because he/she is still technically the owner of the property, even if the keys were mailed to the lender.
For income properties that were originally purchased as such, loan documents will usually have clauses that allow the lender to take control of the property upon commencement of foreclosure and collect all rents. This prevents the owner from using the rents for personal expenses, to keep other real estate afloat, or other uses besides making payments, maintaining the property, or otherwise benefitting the foreclosing lender.
Furthermore, unless the property is in one of the very few states that have anti-deficiency statutes, all those pre-foreclosure costs plus various post-foreclosure costs will be included in the complaint likely filed by the lender in a lawsuit for collection of the loan principal balance amount plus all costs. From that total will be subtracted what the lender can recover from sale of the foreclosed property, potentially significantly less than the price paid for it if the market is low at the time of the sale.
Since, depending on all facts of the specific case, the judgment received by the lender can be quite large, the owner can end up with seizure of many of his/her remaining assets, garnishment of wages, and a seriously damaged credit rating for years to come. Filing bankruptcy may be the only solution to the problem but it is almost certainly only a partial solution for two reasons.
First, there is no guarantee that bankruptcy court will allow Chapter 7 bankruptcy whereby the debt is wiped out. The court may only approve a Chapter 13 bankruptcy whereby a plan is approved that requires payments to at least some creditors over a period of years. Second, the borrower’s credit rating will be a problem for many years.
Accordingly, it is far better to attempt to avoid completion of a foreclosure. An owner in foreclosure should ask the lender if it will accept a short sale or accept a “deed in lieu foreclosure.”
A short sale or a deed in lieu of foreclosure is usually less toxic to your credit rating than a standard foreclosure because it is listed as “settled debt” on credit reports. However, you must get the lender’s approval to sell the home for less (or “short”) of what you owe, and that approval won’t always be granted because the lender takes the loss for the balance owed in this scenario.
In attempting to get approval for a short sale, hardship must be proven to the lender. Additionally, in some states the lender can still technically go after you following the sale to collect the difference, but generally does not because of the legal costs involved and the fact that there is usually little or nothing to be recovered. Many short-sale attempts fail and that puts you back to square one.
The deed in lieu of foreclosure approach is faster than a short sale with about the same possibility in some states of being pursued by the lender for the difference. However, in a deed in lieu of foreclosure, you are contacting the lender and officially stating that you can’t make the payments and believe foreclosure is imminent, so you are volunteering to legally handing over ownership to the bank. This saves the bank the time and expense of foreclosing on you.
However, while accepting a deed in lieu of foreclosure may avoid certain potential future losses for the lender, the lender could end up with certain liabilities that are avoided when completing a foreclosure. This risk may prevent the lender from considering a deed in lieu of foreclosure. Also, previous, current, and expected future market conditions and the financial condition of the borrower along with, if the property is in a state that allow deficiency judgments, lender expectations regarding collection of a deficiency judgment, will influence a lender because the lender doesn’t want to own more foreclosed properties than already held. Sometimes the desire to avoid owning more properties will result in a bank to consider renegotiating mortgage terms rather than adding yet another home to the already-bloated inventories of real estate owned by the bank if they are convinced the owner can solve his problems by having better loan terms.
An offer of a deed in lieu of foreclosure is most likely to be acceptable to a lender who was a seller who carried the financing at the time of sale or who is a lender not in first position, for example, one who provided second mortgage or deed of trust loan. This is particularly true if the lender that is in first position is about to foreclose or has already begun foreclosure on the senior loan. The reason is that the second position lender loses the entire amount owed him/her when the senior loan foreclosure is completed, but would have hope of recouping at least some of his/her loan if he/she becomes the owner. The junior lender would, of course, have to have permission of the senior lender in order to avoid the risk of that lender enforcing the acceleration clause that will be included in any loan made within the past few decades and bring the senior loan current.
Accordingly, there are numerous variables that affect whether the junior lender would try to salvage the loan amount, including the current and expected future values of the property, the current and future rental markets in the area, and whether the foreclosed owner has adequately maintained the property. In other words, the junior lender must decide whether or not it is best to write off his loan or to spend time and energy, as well as possible cash, in order to attempt a save.
Many owners file for bankruptcy after falling into foreclosure when the lender doesn’t consent to a short sale or deed in lieu of foreclosure. This is often because the problems associated with the subject property are not the only financial problems. Also, a bankruptcy may be necessary because the property doesn’t qualify under a state’s anti-deficiency statute or is in a state that has none.
Part 2 of this series will cover some issues related to delayed completion of the foreclosure process, delays being all too common for a variety of reasons.